Economics of International Trade

Question 1

balance of payments

Answer 1

Record that tracks transactions between residents of one country and residents of the rest of the world over a period of time, usually a year.

Question 2

2 accounts included in the balance of payments

Answer 2

1. Current Account:
   indicates how much a country consumes and invests (outflows) with how much it receives (inflows). It includes three components:
   
   • the goods and services account (balance of trade= net exports
   • the income account (salaries + income on financial investments (gifts, workers’ remittance)
   • the current transfers account.
     A current account surplus indicates that the country is saving. That is, the country has more inflows than outflows, so it has the ability to lend to or invest in other countries.
2. The capital and financial account:
   records the ownership of assets. In particular, it reflects investments by domestic entities in foreign entities and investments by foreign entities in domestic entities.

In theory, the sum of the current account and the capital and financial account is equal to zero. -> BP=0

Question 3

types of exchange rate systems

Answer 3

• Fixed rate:
  an exchange rate system that does not allow for fluctuations of currencies. the value of a country’s currency is tied to the value of another country’s currency or a commodity, such as gold.
  the government may want to keep the exchange rates artificially low to increase exports.
• Floating rate:
  the value of a country’s currency changes based on market forces (supply&demand), allowing exchange rates to adjust to correct imbalances, such as current account deficits.
• Managed floating rate:
  a floating exchange rate system in which the central bank intervenes to stabilise its country’s currency, usually to maintain the value of the country’s currency within a certain range.

Question 4

Factors that influence the value of a currency

Answer 4

• balance of payments (current account balance):
  the exchange rate should adjust to correct an unsustainable current account deficit or surplus.
  so, if a country has a large current account deficit, the domestic currency should depreciate relative to foreign currencies.
• level of inflation:
  higher inflation make the currency depreciate.
  inflation erodes the purchasing power of a country’s currency—that is, as prices increase, a unit of domestic currency buys less foreign products and services.
• level of interest rates:
  higher interest rates push the value of the currency higher. (because higher investments -> higher demand of the currency)
• level of government debt:
  high government debt will make investors not want to hold the bonds issued by that government and may sell them and take the money out of the country, which will cause the currency to depreciate.
• political and economic environment:
  capital tends to flow to countries with political stability and strong economic performance which appreciates the currency.

Question 5

Reserve Currency

Answer 5

A currency held in significant quantities by many governments and institutions as part of their foreign exchange reserves. (US dolloar).
It tends to be the international pricing currency for products and services traded on a global market and for commodities, such as oil and gold.

Question 6

purchasing power parity

Answer 6

Economic theory based on the principle that a basket of goods in two different countries should cost the same after taking into account the exchange rate between the two countries’ currencies.